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Over Half of Agency Compensation Deals Involve Pay-for-Performance

Ad Execs Are Divided on Whether Pacts Are Win-Win or Benefit Only the Clients

Bryan Wiener calls them "perverse." Scott Chapman thinks they can be flawed. And Harris Diamond is a "strong believer" in the concept.

Harris Diamond, McCann WorldGroup chairman-CEO

However one views agency-incentive-compensation agreements, they are here to stay. That became abundantly clear at last week's Association of National Advertisers' financial conference in Arizona, where a survey of members -- who collectively control $250 billion in marketing dollars -- revealed that 61% of them are building incentives into their compensation agreements with agencies.

That's a big jump from 46% in 2010 and 35% in 2000, according to the survey, conducted by the ANA and consultancy R3:JLB.

Digital agencies are especially wary of these structures, and all shops acknowledge incentive contracts must be crafted with care so that agencies are fairly evaluated and paid. While the deals should allow shops to get paid on top of basic costs if they achieve or exceed results, agency execs say that's not the direction all marketing or procurement execs are taking.

"Some clients are coming at this from the approach of an opportunity to reduce marketing spend -- and if it starts there, it's flawed from the beginning," said Mr. Chapman, executive director of finance at Rochester, N.Y.-based Partners & Napier. "But if it's a method to fuel performance and success, it can be beneficial." He's noticed more interest in incentive-based plans from clients, and his agency is actively pitching them.

Mr. Goodall, a consultant at R3:JLB, said the most common incentive deals are structured to pay agencies a fee based on proposed staffing, "which can be a pretty substantial revenue stream on an annual basis." Then three tiers of potential bonuses are added, contingent on client sales or market share, brand-recall metrics and an agency-performance evaluation.

Make sure you're seeing eye-to-eye

How can agencies ensure incentive-compensation negotiations are beneficial, not detrimental? Partners & Napier, which is part of the Project Worldwide network, offers advice for agencies to prevent pitfalls.

1. Avoid incentive-compensation deals in the first year of working on an account. The risks are unpredictable when you enter such an arrangement and have no yardstick for historical performance on the business.

2. Create a baseline for compensation. Avoid incentive-compensation deals in the first year of working on an account. Before adding incentives, ensure your base model covers at least half of your staff costs and has cash flow tied to it.

3. See that the agency and the client have incentives tied to the same metrics. Odds for success increase when the marketer's senior-management team is being evaluated and paid according to the same goals the agency's trying to hit.

4. Make sure your role is big enough to have an impact on the client's core metrics. An agency can't realistically be a driver of change if its role is too narrow or if it's just one of many partners without power to make improvements to the bottom line.

Several of McCann WorldGroup's clients have implemented such arrangements and Harris Diamond, the agency's chairman-CEO, says he thinks more will follow.

"I'm a strong believer in incentivization," he said. "The issue is the definition. Is it a true incentivization? It has to have a shared-reward aspect -- it can't be just to get back to where you were on basic costs. These contracts require a lot of thought on both sides, and not all clients are willing to take that risk and maybe have to pay us more, so sometimes the talks go nowhere."

Mr. Goodall noted that if agencies overperform on agreed-upon metrics, the client may have to pay a hefty bonus. But the risks for agencies are very real, too: If the agency really underperforms, it could have to pay back that base fee. "It's not common, but there are ample examples," said Mr. Goodall.

He's observed that most agencies do earn incremental revenue. And he said he believes that such deals motivate agencies to go an extra mile. "They know the target they have to hit and break their backs to make that happen. In the old models, an agency wasn't necessarily incentivized to overachieve. But this is tangible, and they go after it with a vengeance."

Industry execs say media agencies are the most willing to embrace incentive deals (because they are collecting more data and have concrete measurement metrics), followed by creative shops. Digital agencies tend to be on the fence.

To that point, during the ANA conference Mr. Wiener, CEO of Dentsu-owned 360i, called the deals "perverse" because the incentives are often based on paid-media impressions, but digital and social-media campaigns are costlier to create than distribute.

Shane Atchison, CEO of WPP digital agency Possible, said incentive compensation may work for marketers that sell directly to consumers online -- airlines, for example -- if they tap a shop for a specific task, such as search-engine marketing. It's easy to track progress using performance indicators such as sales, he said.

However, it's dangerous for clients to assume that agencies are correctly defining those performance indicators. "By the time you get through the process, attribution is hard," Mr. Atchison said.

For example, agencies may exaggerate the value and cost-benefit of a Facebook campaign, so a discount of 10% for a 20% upside may represent a flawed financial model.